Draghinomics

Events over the week proved once more that one-way-bets do not exist in global financial markets. With some investors in doubt following Mario Draghi’s comments at last month’s Jackson Hole Symposium, the ECB managed to positively surprise investors. The currency, especially, responded strongly to the further increase in “easiness” of the policy stance. Probably, the most important thing for markets was that words (by Draghi) were followed by action (of the ECB).

Key is that this reflects an ongoing “whatever it takes”-mentality at the leadership of the ECB that keeps both the cyclical recovery and sovereign QE hopes alive. Moreover, it inspires daydreaming about a European version of the Japanese regime shift in policy setting that took place late 2012, known as Abenomics (after then elected Japanese Prime Minister Abe), that could create an even more significant asset price reflation in Europe than seen since the peak of the Euro crisis.

The inspiring speech that Draghi gave in Jackson Hole did indeed hint at a more wide-ranging shift in the European policy agenda. He not only emphasised that eroding inflation expectations justify further policy easing, but also pressed for the need of a more comprehensive policy impulse and effective reform package that balances near-term demand support (both fiscal and monetary) and enhancement of the economy’s long-term growth potential.

By further emphasising that the risk of doing too little currently outweighs the risk of doing too much, both the urgency and composition of the message from the ECB President sounds remarkably similar to that of Japanese Prime Minister Abe. However, whether Draghinomics will make a similar impact on European asset prices as Abenomics did on asset prices in Japan remains to be seen. Draghi’s progressive thinking is certainly off to a reasonable start in terms of market impact, as bond yields and the Euro are lower and equity prices are up in recent weeks.

Still, it should not be overlooked that the size of the moves seen so far remains far smaller than what was seen in Japan after the start of Abenomics. For example, the Euro is only down 4% in trade-weighted terms from its peak for the year, while the Japanese Yen dropped around 25% as a result of the shift in policy settings in 2013. It remains early days, however, to judge the impact of Draghinomics as it took 4-5 months in Japan to generate the full impact on bond, equity and currency prices. The political hurdles for some of Draghi’s ideas remain formidable so a repeat of the Japan experience in Europe still seems a stretch, but further steps on a more cautious reflation path cannot be excluded.